Warren Buffett May Know Value, But He Doesn't Know What Money Is

Warren Buffett may be able to spot value, but the poor man has no idea what money is. In his latest screed against gold, Buffett compares the metal of kings to tulips: an asset to be bought either for decorative value or in the hope it can be sold again to a greater fool at a higher price. Gold has little industrial use and does not procreate: “if you own one ounce of gold for an eternity, you will still own one ounce at its end.”

Buffett is correct that an once of gold will never increase nor diminish in size, but he ignores the fact that its value has been steadily increasing for at least 200 years.

According to the Historical Statistics of the United States, in 1800 an ounce of gold bought 11 bushels of wheat. In 1998, even as gold probed a generational low, an ounce purchased 85 bushels. Gold’s purchasing power in terms of copper went from 36 pounds per ounce to 365 pounds during the same time period, and it rose 5.3 times against cotton. Since 1998, gold has continued to rise, tripling against the CRB Commodities Index. Not bad for an inanimate metal the best use of which, according to Buffett, is to be fondled.

The reason for gold’s historical performance is simple: it is money.

Carl Menger, founder of the Austrian School of economics, was the first to explain why every economic agent is “ready to exchange his goods for little metal disks apparently useless as such, or for documents representing the latter.” Most goods are illiquid, meaning transaction costs of trade are high.

Anyone wishing to swap one good for another has two choices. Either he can barter, which requires finding a trading partner with exact coincidence of needs, or he can trade his goods for an intermediate good, more liquid than his own, that will enable him to obtain the goods he seeks from third parties.

The elements of liquidity include spatial considerations, such a low transaction costs, uniformity and divisibility, and general acceptability. They also include temporal characteristics, such as low storage costs, indestructibility, and a stable value over time. These latter qualities allow for savings, which is the basis of all capital formation.

Gold is money because of all the elements it most perfectly embodies the attributes of liquidity. Currency, mere paper at best, can act as money only to the extent it is backed by gold or sound promises to deliver gold.

But why should the value of gold increase over time?

Henry Hazlitt defined inflation as: “an increase in the supply of money that outruns the increase in the supply of goods.” When the opposite happens, when the increase in the supply of goods exceeds the increase in money, prices go down.

Gold mining adds approximately 1.5% to the above ground supply each year, and global economic growth over the past 200 years has been far higher. As long as economic growth continues to exceed gold production, gold’s value will continue to increase.

Buffett claims that gold has no yield, yet its purchasing power has compounded at an annual rate of 0.9% for over two centuries. And, the increase is pure, safe from onerous transaction costs, hidden from the avaricious eyes of the taxman, and immune from the threat of currency debasement.

Buffett is also incorrect about gold’s function: its purpose is not to be hoarded. In the Parable of the Talents, Jesus praises the servants who invest their money and curses the servant who buries his money in the ground. Capital used for productive increase should always outpace money, so it is no surprise that stocks should outperform gold. What is shocking is by how little they have outperformed.

Using Buffett’s own numbers, since 1965 the S&P 500 has compounded by 9.3% per year, as opposed to 8.6% for gold. Since three-quarters of the S&P’s return is compounded dividends, and since its components constantly change, the extra 0.7% return more than vanishes after deducting for taxes and transaction costs. Investing talent in productivity may be good and noble, but sinking capital into the market has enriched only management and the army of middlemen required to navigate the 145,000 pages of federal regulations.

Gold’s value rises gradually with economic growth over the long term, but it spikes when the productive must bury their wealth to protect it from a rapacious state. A Congressman explained gold’s political role in 1948, saying: “If Congress seemed receptive to reckless spending schemes, depositors’ demands over the country for gold would soon become serious.” The Congressman was, of course, Warren Buffet’s father, and he described exactly what is now occurring.

Howard Buffett understood the “connection between money, redeemable in gold, and the rare prize known as human liberty” in a way his son, obviously, does not. Warren writes that a cow, giving milk, is a better investment than gold. And so it should be. But milk can have price controls imposed on it, and cows can be taxed or confiscated. Warren should know, since he constantly agitates for higher taxes.

Government spending at all levels accounts for 40% of GDP and, as Milton Friedman taught, the burden of government is how much it spends, not how much it taxes. The federal government must now borrow more than a third of its expenditures and, when the voluntary contributions known as Treasury bonds dwindle, the state will use more direct methods.

Ultimately, all such experiments in centralized economics fail, and hoarded gold will come back into circulation for productive use. Those wise enough to have held and to part with their gold when liberty reemerges will be rewarded for their husbandry of capital with ownership of productive assets.

Warren Buffett will not be among them. As he says, “What the wise man does in the beginning, the fool does in the end.” When Buffett finally panics into gold, sell it to him.

— Daniel Oliver Jr. is the founder of Myrmikan Capital, LLC, and a director of the Committee for Monetary Research and Education. He has a J.D. from Columbia Law School and an M.B.A. from INSEAD.